In August 2024, the European Commission published a set of frequently asked questions (FAQs) on how to interpret the Corporate Sustainability Reporting Directive (CSRD) requirements, to aid companies with their implementations. It also contains interpretations of certain provisions of the European Sustainability Reporting Standards (ESRS), where legal interpretation from the Commission was deemed necessary.

Among the many topics covered in this document, there are three questions pertaining to disclosures of ‘key intangible resources’. An intangible asset is a subset of the term intangible resources, and is a recognised asset category in financial accounting, providing an interesting use case to better understand the connectivity between sustainability and financial information.

The first question pertains to whether the requirement to report information on key intangible resources includes those intangible assets recognised on the balance sheet. The short answer is yes.

The second question pertains to which entities are required to provide information on key intangible resources. The short answer is all companies in scope of the CSRD.

Both the second and third questions pertain to where to place information on key intangible resources. The short answer is in the management report or the sustainability statements (while not specified, we also note this would include the financial statements for any intangibles meeting the financial accounting criteria).

What are intangible resources?

The CSRD defines ‘key intangible resources’ as “resources without physical substance on which the business model of the undertaking fundamentally depends and which are a source of value creation for the undertaking”. 

Why do we need to disclose them?

The preamble to the CSRD further explains that the Accounting Directive does not require the disclosure of information on intangible resources other than intangible assets recognised in the balance sheet. 

However, it recognises that information on intangible assets and other intangible factors, including internally generated intangible resources, is underreported, impeding the proper assessment of an undertaking’s development, performance and position, and the monitoring of investments. It also recognises that certain information on intangible resources is intrinsic to sustainability matters, and should therefore be part of sustainability reporting. In some cases, it is not possible to distinguish information on intangible resources from information on sustainability matters.

Nonetheless, certain information on intangible resources is intrinsic to sustainability matters, and should therefore be part of sustainability reporting. In some cases, it is not possible to distinguish information on intangible resources from information on sustainability matters.

What you need to know (and why it matters)

To better understand how the CSRD’s consideration of intangibles connects with financial reporting and the conditions under which intangibles are reflected in financial disclosures in Europe, we need to look to the IFRS Accounting Standards and in particular IAS 38 Intangible Assets.

Defining intangibles 

Intangible assets, under IAS 38, are defined using two basic concepts, and recognised only when two additional criteria for each of those concepts are met: 

In practice, the challenges around control may include an absence of legal rights to protect, or otherwise control. While they are a source of value, for example, customer relationships fail to satisfy the definition of intangible assets for accounting purposes, as an organisation lacks sufficient control over the expected economic benefits attributable to the quality of relationships.

Generally, internally generated intangible assets tend to hold low or no value on the balance sheet, while acquired assets tend to be recognised at cost. This is because the probability recognition criterion in paragraph IAS 38 par.21(a) is always considered to be satisfied for separately acquired intangible assets. Additionally, the cost of a separately acquired intangible asset can usually be measured reliably. This is particularly true when the purchase occurs in cash or using other monetary assets.

So it becomes easier to understand that intangibles may not be reflected in financial statements because of limitations of existing standards, either those of recognition or measurement. A comprehensive review of IAS 38 is currently underway by the IASB, and the UK Endorsement Board (UKEB) is monitoring the IASB public consultation for intangibles. 

You can only have intangible assets, never intangible liabilities [small subhead]

There is no magic as to why this is. All liabilities are by definition intangible, meaning there is nothing physical about them. Liabilities are important in the context of sustainability management, and currently covered by financial accounting standard IAS 37 – Provisions, Contingent Liabilities and Contingent Assets, which we will cover further in a future article.

Bringing it all back to sustainability

The European Commission’s response to the first question specifically refers to the holistic approach of considering all intangibles. This allows users to understand how a company may depend on key intangible resources to operate and how these may be relevant for the company’s future value creation, irrespective of whether they would meet the recognition and measurement criteria of the applicable accounting framework. For example, ethical business conduct and data security in the information technology (IT) industry are two essential considerations that directly contribute to a company’s ability to maintain its client relationships and obtain new clients to grow its revenues.

In our introductory white paper, we explain how different types of performance information will be reflected in different locations within the general-purpose financial statements, which are increasingly understood to include three components: Financial Statements, Sustainability Statements, and management discussion and analysis (MD&A).

We also refer to ‘sustainability information’ or ‘sustainability performance information’ as non-financial information about sustainability matters. We refer to ‘financial information on sustainability matters’ as financial information about sustainability matters that fails to satisfy an existing financial reporting measurement or disclosure requirement. And we refer to ‘financial performance information’ as financial performance information that satisfies the existing financial reporting measurement or disclosure requirement, the latter of which must be included in the financial statements (or the notes thereto). 

When it comes to intangibles, here’s what that might look like:

In its response to frequently asked questions, the European Commission specifies that information on intangibles that do not meet financial accounting requirements does not necessarily have to be included in the sustainability statement and may be provided in a different section of the management report as previously noted. 

Understanding the different types of information should not only help reporting practitioners to determine the appropriate location in which to disclose it, but also to articulate an insightful narrative that explains the connection between sustainability and financial performance as we illustrated in the original white paper.

The topic of intangible assets has been the subject of much discussion over the years, in fact the International Valuation Standards Council has undertaken a series of white papers tackling the very issue of including more intangible items within the financial statements. In addition, the IASB launched a comprehensive review of accounting for intangibles in April 2024. 

Any standard-setting move towards making “intangibles more tangible” will help immensely, not only with the accounting for intangible resources but also with the connectivity between sustainability and finance – particularly as such a significant portion of asset values are now off balance sheet given the source and nature of company value.